Exam 10: Transaction and Translation Exposure

The temporal rate method is the most prevalent method today for the translation of financial statements.

Each of the following is another name for operating exposure EXCEPT ________.

A Canadian subsidiary of a U.S.parent firm is instructed to bill an export to the parent in U.S.dollars.The Canadian subsidiary records the accounts receivable in Canadian dollars and notes a profit on the sale of goods.Later,when the U.S.parent pays the subsidiary the contracted U.S.dollar amount,the Canadian dollar has appreciated 10% against the U.S.dollar.In this example,the Canadian subsidiary will record a

Use the information for the following problem(s). Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information. ∙ The spot exchange rate is $1.40/euro ∙ The six month forward rate is $1.38/euro ∙ Plains States' cost of capital is 11% ∙ The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months) ∙ The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months) ∙ The U.S. 6-month borrowing rate is 8% (or 4% for 6 months) ∙ The U.S. 6-month lending rate is 6% (or 3% for 6 months) ∙ December put options for euro 625,000; strike price $1.42, premium price is 1.5% ∙ Plains States' forecast for 6-month spot rates is $1.43/euro ∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro -Refer to Instruction 10.1.If Plains States chooses not to hedge their euro receivable,the amount they receive in six months will be ________.

The basic advantage of the ________ method of foreign currency translation is that foreign nonmonetary assets are carried at their original cost in the parent's consolidated statement while the most important advantage of the ________ method is that the gain or loss from translation does not pass through the income statement.

If the same exchange rate were used to remeasure every line on a financial statement,then there would be no imbalances from remeasuring.

Translation exposure may also be called ________ exposure.

List and define the three types of foreign exchange exposure presented by your authors.

Use the information for the following problem(s). Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information. ∙ The spot exchange rate is $1.40/euro ∙ The six month forward rate is $1.38/euro ∙ Plains States' cost of capital is 11% ∙ The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months) ∙ The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months) ∙ The U.S. 6-month borrowing rate is 8% (or 4% for 6 months) ∙ The U.S. 6-month lending rate is 6% (or 3% for 6 months) ∙ December put options for euro 625,000; strike price $1.42, premium price is 1.5% ∙ Plains States' forecast for 6-month spot rates is $1.43/euro ∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro -Refer to Instruction 10.1.If Plains States chooses to hedge its transaction exposure in the forward market,it will ________ euro 1,250,000 forward at a rate of ________.

Use the information for the following problem(s). Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information. ∙ The spot exchange rate is $1.40/euro ∙ The six month forward rate is $1.38/euro ∙ Plains States' cost of capital is 11% ∙ The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months) ∙ The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months) ∙ The U.S. 6-month borrowing rate is 8% (or 4% for 6 months) ∙ The U.S. 6-month lending rate is 6% (or 3% for 6 months) ∙ December put options for euro 625,000; strike price $1.42, premium price is 1.5% ∙ Plains States' forecast for 6-month spot rates is $1.43/euro ∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro -Refer to Instruction 10.1.A ________ hedge allows Plains States to enjoy the benefits of a favorable change in exchange rates for their euro receivables contract while protecting the firm from unfavorable exchange rate changes.

Under the temporal rate method,specific assets and liabilities are translated at exchange rates consistent with the timing of the item's creation.

Currency risk management techniques include forward hedges,money market hedges,and option hedges.Draw a diagram showing the possible outcomes of these hedging alternatives for a foreign currency receivable contract.In your diagram,be sure to label the X and Y-axis,the put option strike price,and show the possible results for a money market hedge,a forward hedge,a put option hedge,and an uncovered position.(Note: Assume the forward currency receivable is British pounds and the put option strike price is $1.50/£,the price of the option is $0.04 the forward rate is $1.52/£ and the current spot rate is $1.48/£.)

If a firm's balance sheet has an equal amount of exposed foreign currency assets and liabilities and the firm translates by the temporal method,then

Historical exchange rates may be used for ________,while current exchange rates may be used for ________.

________ exposure may result from a firm having a payable in a foreign currency.

Hedging,or reducing risk,is the same as adding value or return to the firm.

Translation exposure measures

Use the information for the following problem(s). Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information. ∙ The spot exchange rate is $1.40/euro ∙ The six month forward rate is $1.38/euro ∙ Plains States' cost of capital is 11% ∙ The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months) ∙ The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months) ∙ The U.S. 6-month borrowing rate is 8% (or 4% for 6 months) ∙ The U.S. 6-month lending rate is 6% (or 3% for 6 months) ∙ December put options for euro 625,000; strike price $1.42, premium price is 1.5% ∙ Plains States' forecast for 6-month spot rates is $1.43/euro ∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro -Refer to Instruction 10.1.If Plains States locks in the forward hedge at $1.38/euro,and the spot rate when the transaction was recorded on the books was $1.40/euro,this will result in a "foreign exchange loss" accounting transaction of ________.

Use the information for the following problem(s). Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information. ∙ The spot exchange rate is $1.40/euro ∙ The six month forward rate is $1.38/euro ∙ Plains States' cost of capital is 11% ∙ The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months) ∙ The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months) ∙ The U.S. 6-month borrowing rate is 8% (or 4% for 6 months) ∙ The U.S. 6-month lending rate is 6% (or 3% for 6 months) ∙ December put options for euro 625,000; strike price $1.42, premium price is 1.5% ∙ Plains States' forecast for 6-month spot rates is $1.43/euro ∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro -Refer to Instruction 10.1.If Plains States purchases the put option,and the option expires in six months on the same day that Plains States receives the euro 1,250,000,the firm will exercise the put at that time if the spot rate is $1.43/euro.

The biggest advantage of the current rate method of reporting translation adjustments is the fact that the gain or loss goes directly to the reserve account on the consolidated balance sheet and does not pass through the consolidated income statement.